Day trading: Why it's hazardous to your wealth

First up, what is day trading? It’s the act of buying and selling shares in quick succession over a short period of time, aka, frequently. Actual day trading can happen in seconds, but the term also refers to people who buy and sell shares in companies they might not understand, to sell them quickly, with the aim being to make a profit. Big names in finance have likened day trading to gambling.

Like O’Shares ETFs Chairman Kevin O’Leary, who said, ‘"Day trading is not investing. Day trading is gambling. Nothing wrong with it. Nothing wrong with Las Vegas either. But it’s not investing’"

And day trading is the opposite to how investing GOAT Warren Buffett suggested when he said, ‘Money is made in investments by investing and by owning good companies for long periods of time’.

Only 1% of active traders are better off

You may have watched The Wolf of Wall Street. Or The Big Short. They make day trading exciting. And sure, we’d love to whip out a couple of Leo’s one-liners! But perception - and Hollywood - isn’t reality. Studies have repeatedly shown that actively trading shares results in worse investment outcomes.

Research out of the University of California found that only around 1% of active traders grow their money more than people who simply put it into an Index that tracks the average performance of the share markets, like the S&P 500 fund, which tracks the 500 biggest companies listed on the US share markets. The University of California study analysed the active trading accounts of the discount broker Charles Schwab over six years, and found that the more frequently people trade, the worse they do. That truth doesn’t make for an exciting narrative at the flicks, but it should be a giant red flag for anyone who wants a way to put their money to work that doesn’t mean they have to watch the markets day in and day out.

Is day trading worth it?

Why do investors show signs of risky behaviour and likely decrease their chances of building long term wealth as they seek out a quick buck? Blame wayward emotions. Warren Buffett’s ominous yet truthful analogy rings true, 'It's only when the tide goes out that you learn who's been swimming naked.' Got your togs on? Ok, you need to get covered.

The fear of missing out (FOMO) is real. Investing FOMO is when you watch a share price soar to new highs, and you realise you've missed an opportunity. On the way up, more and more investors believe blindly buying on the rise is their best shot to avoid missing out altogether - often called ‘herd behaviour’ by economists. FOMO and herd behaviour is an emotional reaction that causes people to invest in an undisciplined way. Emotional investing in volatile markets is best to be avoided.

Can share markets crash?

Markets historically have been rising over time. But what goes up can come down, as we’ve seen in 1929, 2000, 2008, 2020 and 2022.

A share price fall of 10% or more is called a correction, and the S&P 500 Index has - on average - recorded a drop like this every 16 months. A fall of 20% or more is called a bear market. And bear markets are a typical, cyclical part of investing in shares, and historically have occurred around once every seven years. 

So, what do we know about bears? They’re always lurking around the corner. As good as things are today, it's important to think about the risks of short term investing, in comparison to long term investing. With a goal of building long-lasting wealth, we say think long term.

Achtung baby!

According to data scientist Nick Maggiulli, across all 1-day periods since 1915, the Dow Jones has returned a positive return of roughly 52.3% of the time. That’s not much better than a roulette wheel at the casino! 

Holding shares for a longer period, however, can significantly increase those odds. The Dow Jones is a group of 30 large, established companies including Johnson & Johnson, Microsoft and Apple. Over one year, the probability of a positive return extended to almost 70%. Over 20 years, the likelihood of a positive return potentially may jump to 96%. This highlights the difference between casino play (day trading) vs investing over the long term, based on historical averages analysed by data scientists.

Not only may odds improve by investing for longer periods, but studies show that we make terrible traders anyway! Time and time again, research has shown that individual investors lose money or underperform the average market return when trading.

But commission-free investment platforms are designed to enable, and even encourage, investing behaviour that puts long term wealth (and health) at risk. Trading fees, even small ones, serve as a speed bump to slow down decisions that are most likely reactive or emotional. You’ve spent a long time earning that money and growing it too. Why gamble it now?

Protect your wealth with good investment habits

Building healthy investing habits is the best way to avoid making high risk ‘bets’ - and stop you from becoming addicted to day trading. They’ll also give you the confidence you need to ride out the daily, weekly, monthly and yearly ups and downs of the share markets.

Here are four habits to take on board:

• Think long term. Remember, you’re buying a slice of a business or many businesses, and just like the t-shirt shop down the road, they need time to grow.
• Invest mindfully. Be deliberate about why you’re investing and what you’re investing in. Have a plan, have a goal, and stick to them.
• Be a sceptic. Avoid getting swept up in investing fads, herd behaviour and speculative hype. Remember, when share prices are climbing quickly, you’re probably already too late.
• Focus more on avoiding investing mistakes, rather than making the ‘perfect’ move (because there are no perfects when it comes to investing!).

Warren Buffet’s investing advice

Warren Buffett’s tried and tested investing approach may be one to consider, called the 'punch card' approach. Imagine yourself with a punch card - or a coffee card - with only 20 slots (or shots! ☕). These represent the total the investments you get to make in your lifetime. If you could only make 20 investments in your entire lifetime, you may want to think very carefully about a decision to buy or sell today, and are probably more likely to think more long term. After all, buying shares is owning a slice of some or many companies and like you, the people running those companies plan and hope to grow over the long term. So when those inevitable bear attacks come along, you can check those emotions at the door and grab your popcorn to watch the panic knowing you’re not part of it.